Chapter 10 GOVERNMENT IN THE MACROECONOMY

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Chapter 10 - GOVERNMENT IN THE MACROECONOMY

• Economics 11 UPLB
• Prepared by Tirso B. Paris, Jr.
• September 2007

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The Government Budget

• Government budget
• indicates the public sectors expenditures and
  sources of finance
• Net budgetary position
• revenues gt expenditures ? budget surplus
• revenues lt expenditures ? budget deficit
• revenues expenditures ? balanced budget

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Revenues Expenditures (in billion PhP)
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2007 National Budget and Projected Revenues

• Budget PhP 1.126 Trillion
• RA 9401
• social payback to the people for the fiscal
• turnaround of their government
• Proj. Revenues PhP 1.118 Trillion
• Budget Deficit PhP 63 Billion

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The 2007 budget will enable us to

• provide free meals to 1.5 million youngsters as
  incentive for attending class
• recruit 3,000 new policemen
• send about 700,000 scholars to schools and
  colleges
• immunize two million children
• establish 2,400 outlets of Botika ng Barangay
  (Village Pharmacy)
• provide medical insurance to 4.4 million poor
  persons, among others - Secretary Rolando
  Andaya Jr.

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How NG spends the 2007 Budget?

• Economic services (including agriculture, trade
  and natural resource) - 21.8
• Social services (consisting of health and
  education spending) - 28.1
• General public services account for 16.2
• Defense, 4.8
• Debt service, 28.3

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Top Ten Departments

• Education, 128.6 billion
• Public works, 71.2-billion
• Defense, 54.3 billion
• Interior and local government, 51.3 billion
• State universities and colleges, 17.3 billion
• Agriculture, including the AFMA (Agriculture and
  Fisheries Modernization Fund), 17.3 billion
• Transportation, 16.9 billion
• Health, 11.5 billion
• Judiciary, 9.3 billion
• Comelec, 9.17 billion

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Government Revenues 2004
9
GOVERNMENT AND NATIONAL INCOME

• THE THREE-SECTOR MODEL

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Revisions to the Income Determination Model

• Disposable income (YD) - income that households
  are free to spend and save.
• YD Y T
• Where Y- income
• T- taxes
• Aside for convenience, net transfers to
  households 0
• Consumption now depends on disposable income

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Revision to the Consumption Function

• The above implies that
• when ?T ? ?C
• Y C S is now replaced by YD CS
• In a three-sector model,
• AE C I G
• Thus, in equilibrium
• Y C I G

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Derivation of Equilibrium Income Three-Sector
economy

• Assume
• Lump sum taxes
• G is autonomous
• Income and Aggregate Expenditure

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Alternative Equilibrium Condition 3-Sector Model

• Equilibrium condition Y AE
• Equilibrium income is at Y 1,700
• Alternative equilibrium condition
• ST IG
• To illustrate, above values suggest that
• I 100, T 100, G 200
• In equilibrium,
• S YD C 1600 1400 200.
• I G 300 S T

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Algebraic Treatment
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F10.1
AE
AE
Aggregate expenditure (in pesos)
E0
1,700
45º
Y
0
2,300
1,700
Y
Income (in pesos)
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Government spending and equilibrium income

• Main point ?G ? ?AE ? ?Y
• How large is the change in income?

?G 200
?Y (4).(200) 800
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Govt Spending and Y
Aggregate expenditure (in pesos)
Income (in pesos)
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Income taxes and equilibrium income

• Main point ?T ? ?C ? ?AE ? ?Y
• How large is the change in income

Tax multiplier, ? -mpc -0.75 -3
1-mpc 0.25
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F10.3
AE
AE0
E0
AE1
E1
-mpc?T
45?
0
Y1
Y0
Y
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Fiscal Policy

• Fiscal policy - a collective term that refers to
  the use of taxation and government spending to
  influence the level of income
• Expansionary fiscal policy - spending and
  taxation aimed at increasing income
• e.g. , ?G or ?T
• Contractionary fiscal policy - spending and
  taxation aimed at decreasing income
• e.g., G? or T?

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Deflationary Gap

• Full employment level of income or output (Yf)
• level of income wherein the economys resources
  are fully utilized.
• Note Y not always equal to Yf
• Deflationary gap ? when AE lt Y at Yf
• Note With deflationary gap, Y lt Yf ?
  unemployment
• To close gap, AE must ? such that Y Yf
• Expansionary fiscal policy is required to make
  the AE shift up

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F10.2
Deflationary Gap
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Numerical Example Deflationary Gap

• If Yf 2,000 a deflationary gap exists since Y
  lt Yf.
• To close gap, use expansionary fiscal policy,
  e.g., ?G
• By how much should G ??
• GapG (Yf -Y)/?G
• (2,000 1,700)/4
• 75

In our example C 200 0.75 (Y- T) I
100 T 100 G 200 Y 1,700 ?G 4
?T -3
Thus, G should increase by 75 so that Y Yf
Check Y1 (200 100 275 - ).75(100) . 4
2,000
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Inflationary Gap

• Inflationary gap ? when AE gtY at Yf
• There is pressure for an increase in the general
  price level (inflation) because it is not
  possible to produce beyond Yf.
• To close gap, can use contractionary fiscal
  policy to shift the AE schedule down

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F10.3
Inflationary Gap
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Numerical Example Inflationary Gap

• If Yf 1,500 an inflationary gap exists since
  Y gt Yf.
• To close gap, use contractionary fiscal policy,
  e.g., ?T
• By how much should T ??
• GapT (Yf-Y)/?T
• (1,500 1,700)/-3
• 66.67

In our example C 200 0.75 (Y- T) I
100 T 100 G 200 Y 1,700 ?G 4
?T -3
Thus, T should increase by 66.67 so that Y Yf
Check Y1 (200 100 200) - .75(166.67) .
4 1,500